New Money Fund Rules Could Create Headaches For Transfer Agents

The Securities and Exchange Commission's new rules to improve liquidity and disclosure for money market funds spared the $3.2 trillion industry from the cumbersome operational task of marking value of shares to market every day.

The bad news is the burden is now on the back office. Money market funds must adapt their customer service procedures and information systems to more frequently disclose their "shadow net asset values" and modify their transfer agent systems to be able to process orders and redemptions at a price other than $1 a share.

There are also new restrictions on the investments money market funds can make, which could require alterations in their investment compliance systems.

Meanwhile, however, the SEC is still examining whether a floating price would protect investors from runs on funds, and the SEC may eventually adopt a real-time floating net asset value and require mandatory redemptions in-kind for large redemptions of money in customers' accounts.

Money market funds today list an artificial price of $1 a share even though that may not be the real value. They also report their "shadow net asset values" to the SEC twice a year. These are the true values the shares would actually possess if marked to the value of the assets that the money in the funds has been invested in. The "shadow" values don't get reported to investors.

Under the SEC's new rules, money market funds would be required to disclose to investors the "shadow" or floating share price every month, although the results each month would not be reported for 60 days. The move is designed to get investors used to the idea their shares do not always maintain a stable $1-a-share value.

"Requiring money market funds to disclose a shadow net asset value on a delayed basis is a step toward ensuring more transparency in the actual value of the shares," said Peter Crane, president of Crane Data. "But either disclosing a floating rate or shadow price could be misinterpreted by investors who think that their fund has broken the buck."

Crane believes that because of the delay in reporting, the information isn't likely to mean much to investors if the money fund is already at risk of breaking the buck. That is because the fund will have already seen a wave of redemptions or would have already repriced its shares. However, as Crane warns, money market funds and their transfer agents need to prepare for the barrage of calls from investors not understanding how their fund is valued.

"We do have some apprehension about just how investors will react," one operations executive at a New York money market fund told Securities Industry News. "The calculations aren't that difficult to calculate more frequently, but disclosures are problematic, and we are preparing ourselves for an onslaught of calls from bewildered investors." His firm calculates shadow net asset values on a weekly basis.

More operationally challenging to money market funds will be the SEC's requirement that they can electronically process investors' purchases and redemptions at a price other than $1 a share to allow for an orderly wind-down of assets to investors. That is even though a fund's board can halt redemptions, if a fund breaks the buck.

"Such a scenario would make it easier for investors to get their money back if a fund breaks the buck, but not all transfer agency systems will be prepared for such a scenario," said Roger Joseph, director of the investment management practice at Bingham McCutchen in Boston. "They are hard-coded for a $1 a share price."

Bruce Treff, North American head of regulatory and compliance services for Citigroup's fund services unit, which provides fund administration and transfer agency services to money market funds, said if a floating NAV is imposed on money market funds, Citi would need reconfigure its transfer agency system to identify money market funds as having a variable net asset value rather than a fixed net asset value.

"That change won't require major programming work, but we would need to ensure that any investor calling to redeem its share doesn't get more or less money than they are supposed to," he said.

Such an error could occur, according to Treff, if the net asset value of the money market fund ends up being reduced or increased after the investor has already made their redemption request. "There has to be a mechanism built into the transfer agency system to hold up the wire until it can be determined that the correct amount has been liquidated from the shareholder's account," he says. "Alternatively, the transfer agent needs to ensure that it has received the correct amount to fund a shareholder's subscription."

Allowing investors to buy or redeem shares at a price other than a $1 a share also requires that money market funds be capable of preparing tax statements to account for capital gains and losses. Money market funds do so only for dividend payments because the price of the share has never fluctuated.

Most of the other changes the SEC now requires involve reducing investment risk and ensuring funds have sufficient liquidity to make redemptions on the day they are requested by investors. For example, taxable money market funds will now be required to maintain 10% of their assets in a "daily liquidity bucket," and all money market funds must maintain 30% of their assets in a "weekly liquidity bucket." Money market funds can invest no more than 5% of their assets in illiquid securities instead of the current 10%. In addition, the permissible weighted average maturity for the fund's portfolio has been reduced to 60 days from 90 days, and funds must now comply with a new "weighted average life" portfolio limit of 120 days.

"The weighted average life restriction likely means that the portfolio manager will limit the amount and types of variable rate and floating rate securities they invest in because these securities often have longer final maturities," said Timothy Levin, a partner with Morgan Lewis & Bockius in Philadelphia. "The new restrictions will likely have to be coded into a portfolio manager's compliance system to ensure that the liquidity baskets and maturity calculations are being monitored on an ongoing basis."

While the SEC's new rules will have the greatest impact on fund accounting and transfer agency systems, custodian banks may also have to brace themselves for some change. "Financial intermediaries that use money market funds as sweep vehicles for their customers must also ensure their systems can accommodate a fluctuating net asset value," says Bingham McCutchen's Joseph.

Custodian banks, representing fund managers, typically reinvest cash posted by borrowers to collateralize their securities lending transactions in short-term liquid accounts, including money market funds." Fund managers, in turn, that participate in the collateral pool will also need to make certain their accuonting systems can accommodate a collateral pool NAV of more or less than $1," he notes."